Last Wednesday, markets were hit with meetings at both the Bank of Japan and the Federal Reserve. And the emerging markets lived to tell about it.
And, boy, did they tell about it … but they might be telling the wrong story.
The central banks’ policy decisions, as announced to reckless anticipation, were not surprising.
Well, at least not yet.
The BOJ decided it’s going to keep its foot on the gas of monetary easing. It’s just going to use a different pedal.
Instead of more deeply plumbing the depths of negative interest rates, they will target the shape of the yield curve — i.e., targeting 10-year rates at 0%.
And they will not stop till inflation breaks above 2%.
If the last 25 years of history is any indication, the BOJ won’t stop easing until … well … ever.
On to the Fed …
Janet Yellen and her team told us they are not hiking rates. But they will soon. They swear!
The market is calling the Fed’s bluff.
Are they bluffing? Are they just pretending that they’ll actually take another step toward rate "normalization"?
After all, LIBOR is already presenting the system with tighter financial conditions. Let’s not get all crazy by moving the Fed’s benchmark rate of interest up to a whopping 50-75 basis points. (That is sarcasm, my friends.)
At the same time, when the Fed says it has "decided, for the time being, to wait for further evidence of continued progress toward its objectives" …
Do they mean to say "growth just ain’t happenin’"?
They keep revising lower their own growth projections:
No surprise here.
And, all things being equal, that line is heading toward the zero bound. There is no other possibility considering the debt and leverage out in the economy.
But let’s leave that alone … because low or no growth seems like the least significant worry on the minds of central bankers.
The primary concern is that of capital flow and asset prices.
And what better indication of those two things than emerging markets?
I gave subscribers of my Currency Options Alert service a full rundown of what’s going on with emerging markets recently, and why EM debt and equities are going ballistic.
Here is an excerpt:
Investors have sharply increased their positioning in emerging markets (relative to developed markets) this year, according to the BoAML Fund Manager Survey.
Now, offhand I don’t know if this positioning includes emerging-market equities or debt, or both (or more).
But a simple look at the EEM chart I gave you with last week’s recommendation is indicative of the appetite for emerging-market equities.
The appetite for EM debt is perhaps even stronger.
Think about it: The whole risk-appetite move into developed-market and emerging-market equities is about finding return … Same for EM sovereign debt.
Unfortunately, as I went on to say, the draw to emerging markets this year is strictly part of the risk appetite ebb-and-flow; it doesn’t seem to have anything to do with the underlying merit of those EM economies and investments.
And if you want evidence, just look at how the EM world responded to the Fed decision last week:
EM bonds, stocks and currencies — oh my!
Good for those who have exposure to emerging markets. Except for when the music stops playing.
See, here is what it all comes down to — literally:
The Fed is carrying the weight of world asset prices on its shoulders. It knows that and might not be too fond of the privilege … even if its powerful, moneyed backers like the perks.
And if the Fed has any intention of preserving its publicly perceived efficacy, they cannot afford to keep fueling a market dislocation: a huge gap between growth and debt, a huge gap between asset valuations and growth, a bubble.
It seems to me they are quite close to talking the markets down off the ledge.
Was last week’s kneejerk reaction — RISK ON, YAY! — indicative of late-to-the-game dumb money deciding they ain’t gonna miss the rocket ride again?
If it is, a rough landing is probably ahead.
And things like the iShares MSCI Emerging Markets (EEM) and iShares JPMorgan USD Emerging Markets Bond (EMB) are probably in for the roughest landing since they are so sensitive to Fed-induced capital flows.
Be warned. And be ready.